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Broker-Dealers vs. Registered Investment Advisors

Every investor works with financial institutions in some capacity, whether it's simply to execute trades or to provide guidance in coming up with particular investments or broad-based strategies. One source of confusion involves the different categories of institutions that provide such guidance. In particular, broker-dealers and registered investment advisors both offer their services to investors, but few investors know the difference between them. Below, you'll learn more about each group to find out which one fits your needs better.

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Differences in regulation The most important difference between broker-dealers and registered investment advisors is how each group gets regulated. Investment advisors have a fiduciary duty to their clients that requires them to put their clients' interests ahead of their own. Advisors who have a conflict of interest, such as by receiving compensation for certain products they sell, must fully disclose the conflict or eliminate it. Additionally, an advisor isn't allowed to conduct trades directly for the advisor's own institutional account with clients unless details about the transaction are released to the client and the client gives consent.

By contrast, broker-dealers that work with the public typically become members of the self-regulatory Financial Industry Regulatory Authority, or FINRA. Broker-dealers owe a duty of fair dealing with their clients, which is generally seen as being less onerous than the fiduciary duties that registered investment advisors owe their clients. In particular, broker-dealers must not sell investments to their customers unless those investments are suitable for the customer's needs. When making a recommendation of particular investments, broker-dealers must disclose material conflicts of interest.

Sources of compensationBecause of these different regulatory standards and duties to clients, broker-dealers and registered investment advisors typically get compensated differently. Broker-dealers gravitate toward transaction-based compensation such as trade commissions, and as a result, some consumer advocates have warned their clients against improper practices like account churning to generate extra commission income.

By contrast, registered investment advisors often work on asset-based fees, earning a percentage of assets under management regardless of how many transactions a client does. Proponents of this method argue that an asset-based fee takes away perverse incentives to trade unnecessarily, but some note that with this form of compensation, an advisor need do nothing and can still earn income year after year.

As an investor, you can get solid advice from either a broker-dealer or a registered investment advisor. The key is to understand the different ways each will behave and to anticipate some of the areas in which the professional you're working with might not be objective. Knowing the danger signs in advance is a good way to weed out unsuitable professionals from those who truly want to help you.

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